THE rate of inflation has plunged to 0.2 per cent in August, new figures showed today – but what does it actually mean and how does it affect your finances?
Here, we take you through everything you need to know about inflation, from how it’s measured to what it means for interest rates.
Read our coronavirus live blog for the latest news & updatesInflation looks at the price of goods and compares them to a year ago[/caption]
What is inflation?
Inflation measures the cost of living by looking at the price of goods, such as groceries and mobile phones, and services such as haircuts and rail fares, and how it’s changed over time.
Usually people measure inflation by comparing the price of things today with how much they cost a year ago.
The average increase in prices is known as the inflation rate.
The Bank of England uses inflation as one of the key indicators when it sets the base interest rate, which banks use to determine how much they will charge borrowers and pay savers.
It’s measured by the Office for National Statistics (ONS) and there are three main estimates: the Consumer Prices Index (CPI), the Consumer Prices Index including homeowner housing costs (CPIH) and the Retail Prices Index (RPI).
The CPI is the figure that most people look at because state benefits and the state pension also rise inline with it.
The research released on September 16 showed that CPI has dropped to 0.2 per cent in the year to August, down from 1 per cent in the year to July, and that the Eat Out to Help Out scheme was to blame.
The government sets an inflation target of 2 per cent.
What does high inflation mean?
If inflation is too high, say above the government’s target rate, or it moves around a lot, the Bank of England says it is hard for businesses to set the right prices for people to plan their spending.
For borrowers, high inflation can reduce their debt if they’re locked into a repayment plan, such as a fixed-rate mortgage.
But for savers it means their cash may not stretch as far in the future as things cost more.
High inflation can also have an impact on wages as workers will need more money to live.
What is the base rate?
SIMPLY put, it’s the country’s official borrowing rate, and is the rate the Bank of England lends to all the other banks in the UK.
It is incredibly important as it a guide for lenders on what rates it can offer – and therefore impacts mortgage rates, credit cards, loans and savings.
It was stuck at record low levels for a decade because of the state of the economy after the financial crash in 2008.
It was raised back to 0.5 per cent last November, the first of what many had hoped would be three hikes within three years.
The rate went up again in August 2018 to 0.75 per cent and has been held there ever since until the beginning of March when it was slashed to 0.5 per cent again.
The shock announcement at the end of March – where it dropped to 0.1 per cent – means it’s now below a level not seen since before 2016.
If interest rates soar too fast, it’s called hyperinflation.
This can happen if the government prints more money, which pushes up prices as there’s more of it around.
It’s a worrying situation to be in and very hard to get out of.
One famous example is when Germany printed more cash to pay off its debts after World War One, causing the currency to lose its value.
And Zimbabwe was forced to ditch the Zimabwean dollar in 2008 after inflation hit a staggering 500billion per cent.
Is low inflation a good thing?
The Bank of England says that it aims for a low and stable inflation rate as it’s good for the UK’s economy.
Low inflation rates means that prices will drop making cash go further.
The interest paid on savings is also likely to increase to above the rate of inflation, meaning you earn more on your nest-eggs.
But if inflation falls too low, or goes into negative rates, some people may be put off spending because they expect prices to fall further.
If everybody reduced their spending then companies could fail and it could lead to wage cuts and job losses.
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Interest rates are unlikely to rise if the UK is in a state of negative inflation, which on the surface is bad for savers but good for those paying back debt.
But in reality, making debt repayments becomes harder if you become unemployed and job prospects remain low.
Some experts have said we could see negative inflation as a result of coronavirus pressures on the economy.